Code Section 402(g)(7) seems to have a gift for certain 403(b) plan sponsors (that is, for “qualified organizations, being educational organizations, hospitals, home health service agencies, health and welfare service agencies, churches, or convention or association of churches): the annual elective deferral limit for participants in these plans with “15 years of service” with the qualified organization can be as much as $3,000 greater than the existing limit for everyone else, up to a lifetime maximum of $15,000.
When you are restating your 403(b) plan documents, and you come across this election, your first impression may well be “why not? What a great benefit for the more senior employees!”
You should, however, pause at that moment, and consider the details of what it takes to be able to support providing this benefit. It’s not what it seems to be, and it truly has become an “attractive nuisance.”
An attractive nuisance is a term used in personal injury law to describe a dangerous circumstance on one’s property–such as a deep pool or pond–which will be attractive to children. If the property owner has not taken precautions to prevent children from accessing that “nuisance ” that owner may be liable for any harm done to that child who then jumps in that pond and is hurt.
The 402(g)(7) “long service catchup” is of that character. At the very least, it’s a terrible trap for the unwary. It is a benefit which is virtually unsupportable except for those employers with sophisticated payroll systems which have also been programmed over an extended period of time to calculate and store the data needed to provide this benefit.
The devil, as in all else 403(b), is in the details:
- 402(g)(7)(D) requires that the definition of “years of service” which is to be used in calculating the 15 year catchup is the “meaning given to such term by section 403(b).”
- 403(b)(4) provides the definition of years of service for 403(b) plans. It only has a passing similarity to the “years of service” used for vesting and participation under sections 410 or 411, or even under ERISA Title 1. One must count:
- one year for each full year during which the individual was a full-time employee of the organization purchasing the annuity for him, AND
- each fraction of a year for each full year during which such individual was a part-time employee of such organization and for each part of a year during which such individual was a full-time or part-time employee of such organization.
- 1.403(b)–4(e) provides the special rules for computing the fractional “work periods” to be used in computing the 15 year catch-up (they are extensive, some 1435 words).
- 1.403(b-2(b)(11) then provides the special rules for determining the participant’s “includible compensation,” which must be used to determine the 415 limitation on those long service contributions, which is different than the general compensation rules used elsewhere in the plan for all other purposes.
Why does this all matter? Because no employer that I’ve ever encountered actually collects and properly calculates both partial years of service and includible compensation for those periods, nor has the ability to do so (though I’ve little doubt there may be a handful of employers which do)-and I suspect the IRS has also found a lack of documentary support for these calculations in its reviews. And, yes, if you’ve adopted this rule, the Service will ask for this data on audit if you have elected the benefit.
Which is why you should pause before checking that box adopting the 15 year catch-up. If you do not have the data to establish the eligibility for the benefit, you will then suffer a CAP penalty on audit.
Our advice always is to be not misled: the long service catch-up can only be best described as an attractive nuisance. Just don’t do it.
I would also like to send a shout out to the Treasury and IRS’ staff who participated in the 2019 ABA Joint Fall Tax Meeting this past week. I do this not to curry favor, in the same way I do not seek to demean in my technical critiques of their work over time. I left the meetings with the impression that we do need pause to recognize the work they do from time to time. It is complex and demanding, and they are incredibly good at it. Balancing competing (and very serious) policy and statutory concerns while drafting language which must also prove to be useful to sponsors, participants and vendors is no mean feat. They represent “good government” in an era where it seems that the notion of public service is too often trampled upon. A tip of the hat to you all.